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August 3, 2012

ECB Battle: Draghi vs. Weidmann

Bundesbank president still opposes bond buying to stem crisis

The European Central Bank headquarters in Frankfurt. (Photo: AP)

While European Central Bank (ECB) President Mario Draghi’s lack of direct and drastic action on Thursday disappointed markets, he’s thrown down the gauntlet in challenging Bundesbank President Jens Weidmann’s opposition to a plan for the ECB to reenter the bond markets.

Bloomberg reported Friday that Draghi took the unusual step of calling out Weidmann by name in his Thursday comments about tactics the ECB could use against the financial crisis. Among those tactics is a resumption of bond purchases, something the ECB had halted in March but which is now being discussed again.

Draghi announced a bond purchase plan currently being worked out by the ECB, although its actual execution remains weeks away—a fact that put a damper on markets. However, the ECB said that it would buy Italy’s and Spain’s bonds on the market, provided that the European Stability Mechanism (ESM) also buys bonds—directly from the two countries’ treasuries—and does so only under stringent conditions.

After his announcement about the plan, Draghi was quoted saying, “It’s known that Mr. Weidmann and the Bundesbank have their reservations about programs that buy bonds.”

Weidmann has been known to oppose such an action, conditions or no, and two German members of the ECB’s Governing Council had quit the central bank in protest over its bond-buying program. Still, being called out in public as the sole member of the ECB to stand against the action is a violation of previous policy; the ECB does not reveal votes of individual policymakers or minutes of its meetings so that members are protected from political pressure.

Public disagreement wasn’t lacking in the Bundesbank’s approach to the matter, however. After Draghi referred to a bond-buying program in a London speech several days ago, a Bundesbank spokesman repeated the German central bank’s opposition to any such action.

On Aug. 1, Weidmann himself was quoted saying, “We are the largest and most important central bank in the eurosystem and we have a greater say than many other central banks in the eurosystem.” He added that the ECB’s independence “requires it to respect and not overstep its own mandate”—which, according to Weidmann, does not include buying bonds.

The Bundesbank’s opinion and Weidmann’s vote both carry a lot of weight. Although Weidmann is only one voice on the ECB’s 23-member council, that voice carries. Julian Callow, chief European economist at Barclays in London, said in the report, “The Bundesbank veto matters a lot in this. We need to know exactly how the Bundesbank is appraising things.”

According to Alexander Krueger, chief economist at Bankhaus Lampe in Dusseldorf, the market’s lackluster reaction to Draghi’s policy announcement on Thursday can be explained by Draghi’s apparent override of Weidmann’s position against bonds. Krueger was quoted saying, “That’s why investors are disappointed. The ECB can’t just take random measures against the Bundesbank’s will. The country with the largest economy needs to be part of any package.”

Of course Weidmann is not the only policymaker from Germany opposed to the policy; his predecessor, Axel Weber, and Juergen Stark, former chief economist for the ECB, both resigned last year over the original bond purchase program that began in May of 2010. And in Germany the notion is unpopular with the general public as well.

That was reflected in an article in the German daily Bild, which criticized the plan and said, “No more German money for bankrupt states, Herr Draghi!” The Bild, according to a Telegraph report, also threatened to reclaim the Prussian helmet it had presented to him months ago that was intended to remind him of German virtues, saying, "Otherwise Bild wants the 'Pickelhaube' back."

Still, public opinion on his side or not, “Weidmann was unhappy before but he’s probably even more unhappy now after being name-checked like that by Draghi,” said Jacques Cailloux in the report.

Cailloux, chief European economist at Nomura International in London, added, “The Bundesbank has to live with being outvoted, but it remains to be seen whether it really goes to the wire, blocks the program and refuses to buy the bonds.”

Whether it is characterized as a “random action” or not, the bond purchase program is believed by some to hold the key to quelling the crisis. Charles Diebel, head of market strategy at Lloyds Banking Group in London, was quoted saying, “All of the announcements, if transferred into actual activity, would be close to the big bazooka approach that the markets are looking for. Market disappointment is hardly surprising in this context but we may well find this lays the groundwork for the grand plan in coming weeks.”

Holger Schmieding, chief economist at Berenberg Bank in London, concurred, and was quoted saying, “Whatever the short-term gut reaction of markets, the ECB announcement constitutes serious progress.” He added, “The chances have risen substantially that the worst of the current wave of euro crisis could soon be over.”

Still, all is not smooth sailing from here on. One condition for the bond purchases is that the country must ask for them. Neither Mario Monti, prime minister of Italy, nor Mariano Rajoy, prime minister of Spain, have indicated that their countries will do so. In fact, Monti said in the report, “I don’t know if the Italian government will ask for activation of this instrument.” Rajoy declined to comment on the possibility that Madrid will ask for aid.

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